New research has highlighted the “hidden ethics” behind climate investment frameworks that prevent standardisation in the space.
A paper published by fintech start-up Scientific Portfolio claims that for “even the most apparently scientific data-driven processes, certain key decisions are unavoidably ethical in nature”.
It builds on work done last year by the firm, which is a spin-off from French business school EDHEC, that sought to identify why providers of seemingly similar temperature alignment scores offered such divergent results.
“Investors considering how to align equity portfolio ‘emissions’ with climate-related targets are immediately faced with a daunting reality: the significant inconsistencies between different methodologies,” the authors wrote.
They previously established various design choices that are made when creating methodologies, and identified the ones with the biggest influence on the final outcomes.
Now, they are exploring which of those choices are dictated by technical preferences and which are values-driven.
“Various essential steps, such as the selection of targets and metrics, cannot be standardised based on scientific principles and instead require ethical choices,” argued the paper.
“Indeed, the heterogeneity of climate metrics and methodologies – a challenge that continues to provoke calls for standardisation – can often be traced, at least in part, to unspoken ethical divergence.
“This creates something of a practical challenge for many investors and practitioners that have not explicitly defined the ethical basis of their stance.”
“Investors should make deliberate choices that are consistent with their own – clearly defined and transparent – ethical stance”
The ethical choices Scientific Portfolio identifies generally centre on how responsibility for achieving net zero should be assigned across the global economy.
For example, on scientific grounds, the goals of the Paris Agreement can be reached by just reducing Scope 1 emissions. But many investors believe companies whose business models rely on carbon-intensive suppliers or customers should be held accountable for that.
Similarly, perceptions about fairness – how the remaining carbon budget should be shared across generations and regions – can influence an investor’s ambition levels.
On the back of this, the research identifies three types of investment approaches.
The ‘principled investor’ values universal principles that, if adopted by all companies, would achieve scientific climate goals. It therefore doesn’t distinguish between sectors and regions, prioritises Scope 1 emissions, and measures absolute emissions.
The ‘utilitarian investor’ focuses on Scope 1 and 2 carbon intensity, not absolute emissions. It therefore favours companies that maximise the profits they make from each unit of emissions.
Finally, the ‘harmonist investor’ advocates for an extended scope of responsibility, incorporating Scope 3 emissions and sectoral and regional differences.
Scientific Portfolio applied each approach to the same developed-markets equity portfolio, finding that all three achieved similar levels of overall excess emissions, but with major differences.
For the airline sector, for example, the principled investor’s focus on pursuing an equal level of Scope 1 decarbonisation across all companies resulted in an overshoot of 162%. The harmonist investor, on the other hand, prioritised emissions per passenger-kilometre and got an overshoot of -10%.
This would allow the latter to retain bigger exposure to the sector and still be on track for its climate targets.
“Based on this analysis, we would argue that standardised uniform metrics for climate alignment are not appropriate,” the paper’s authors wrote.
“The significance of ethical choices in their construction means that the industry should continue to offer a variety of approaches. Meanwhile, investors should make deliberate choices that are consistent with their own – clearly defined and transparent – ethical stance.”
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